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(8th Edition)

Chapter 5
Some Important Discrete
Probability Distributions

Chapter Topics

##  The probability of a discrete random variable

 Covariance and its applications in finance
 Binomial distribution
 Poisson distribution
 Hypergeometric distribution

## © 2002 Prentice-Hall, Inc. Chap 5-2

Random Variable

 Random variable
 Outcomes of an experiment expressed
numerically
 e.g.: Toss a die twice; Count the number of
times the number 4 appears (0, 1 or 2
times)

## © 2002 Prentice-Hall, Inc. Chap 5-3

Discrete Random Variable

##  Discrete random variable

 Obtained by counting (1, 2, 3, etc.)
 Usually a finite number of
different values
 e.g.: Toss a coin five times;
Count the number of tails
(0, 1, 2, 3, 4, or 5 times)

## © 2002 Prentice-Hall, Inc. Chap 5-4

Discrete Probability
Distribution Example
Event: Toss 2 Coins. Count # Tails.

Probability Distribution
Values Probability

T 0 1/4 = .25
1 2/4 = .50
T 2 1/4 = .25

T T
© 2002 Prentice-Hall, Inc. Chap 5-5
Discrete Probability Distribution

##  List of all possible [Xj , p(Xj) ] pairs

 Xj = value of random variable
 P(Xj) = probability associated with value
 Mutually exclusive (nothing in common)
 Collectively exhaustive (nothing left out)

0  P X j  1 P X  1 j

Summary Measures

## Expected value (the mean)

Weighted average of the probability
distribution:

  E X    X jP X j 
j

Summary Measures
continued

## Example of expected value (the mean):

Toss two coins, count the number of tails,
compute expected value

   X jP X j 
j

## © 2002 Prentice-Hall, Inc. Chap 5-8

Summary Measures
(continued)

Variance
 Weight average squared deviation about
the mean

  E  X        X j    P  X j 
2 2 2

 

## © 2002 Prentice-Hall, Inc. Chap 5-9

Summary Measures
(continued)

Example of variance:
Toss two coins, count number of tails,
compute variance

   X j    P X j 
2 2

2 2 2

## © 2002 Prentice-Hall, Inc. Chap 5-10

Covariance and its Application
N
 XY    X i  E  X   Yi  E Y  P  X iYi 
i 1

## X : discrete random variable

X i : i th outcome of X
Y : discrete random variable
Yi : i th outcome of Y
P  X iYi  : probability of occurrence of the i th

## outcome of X and the i th outcome of Y

© 2002 Prentice-Hall, Inc. Chap 5-11
Computing the Mean for
Investment Returns
Return per \$1,000 for two types of investments

Investment
P(XiYi) Economic condition Dow Jones fund X Growth Stock Y
.2 Recession -\$100 -\$200
.5 Stable Economy + 100 + 50
.3 Expanding Economy + 250 + 350

## E Y   Y   200.2   50.5   350.3  \$90

© 2002 Prentice-Hall, Inc. Chap 5-12
Computing the Variance for
Investment Returns
Investment
P(XiYi) Economic condition Dow Jones fund X Growth Stock Y
.2 Recession -\$100 -\$200
.5 Stable Economy + 100 + 50
.3 Expanding Economy + 250 + 350

2 2 2 2
X

##  14, 725  X  121.35

  .2  200  90   .5  50  90   .3 350  90 
2 2 2 2
Y

 37,900  Y  194.68
© 2002 Prentice-Hall, Inc. Chap 5-13
Computing the Covariance
for Investment Returns
Investment
P(XiYi) Economic condition Dow Jones fund X Growth Stock Y
.2 Recession -\$100 -\$200
.5 Stable Economy + 100 + 50
.3 Expanding Economy + 250 + 350

##  XY   100  105 200  90 .2   100  105 50  90 .5

  250  105  350  90 .3  23,300
The Covariance of 23,000 indicates that the two investments are
positively related and will vary together in the same direction.
© 2002 Prentice-Hall, Inc. Chap 5-14
Important Discrete
Probability Distributions

Discrete Probability
Distributions

## © 2002 Prentice-Hall, Inc. Chap 5-15

Binomial Probability Distribution
 “n” Identical trials
 e.g.: 15 tosses of a coin; 10 light bulbs taken from
a warehouse
 Two mutually exclusive outcomes on each
trial
 e.g.: Heads or tails in each toss of a coin;
defective or not defective light bulb
 Trials are independent
 The outcome of one trial does not affect the
outcome of the other

## © 2002 Prentice-Hall, Inc. Chap 5-16

Binomial Probability Distribution
(continued)

##  Constant probability for each trial

 e.g.: Probability of getting a tail is the same
each time a coin is tossed
 Two sampling methods
 Infinite population without replacement
 Finite population with replacement

## © 2002 Prentice-Hall, Inc. Chap 5-17

Binomial Probability
Distribution Function
n!
P X   p 1  p 
X n X

X ! n  X !
P  X  : probability of X successes given n and p
X : number of "successes" in sample  X  0,1, , n
p : the probability of each "success"
n : sample size Tails in 2 Tosses of Coin
X P(X)
0 1/4 = .25
1 2/4 = .50

2 1/4 = .25 Chap 5-18
Binomial
Distribution Characteristics
 Mean
   E  X   np
 e.g.:   np  5 .1  .5

##  Variance and P(X) n = 5 p = 0.1

.6
standard deviation .4
  2  np 1  p  .2
0 X

  np 1  p 
0 1 2 3 4 5

 e.g.:
  np 1  p   5 .11  .1  .6708
© 2002 Prentice-Hall, Inc. Chap 5-19
Binomial Distribution in PHStat

Binomial

## © 2002 Prentice-Hall, Inc. Chap 5-20

Poisson Distribution
 Poisson process ( x|
PX
Discrete events in an “interval”
e- x

##  The probability of one success

in an interval is stable x!
 The probability of more than

## one success in this interval is 0

 The probability of success is
independent from interval to
interval
 e.g.: The number of customers arriving in 15
minutes
 e.g.: The number of defects per case of light bulbs
© 2002 Prentice-Hall, Inc. Chap 5-21
Poisson Probability
Distribution Function

e  X
P X  
X!
P  X  : probability of X "successes" given 
X : number of "successes" per unit
 : expected (average) number of "successes"
e : 2.71828 (base of natural logs)
e.g.: Find the probability of four e3.6 3.64
customers arriving in three P X    .1912
4!
minutes when the mean is 3.6.
© 2002 Prentice-Hall, Inc. Chap 5-22
Poisson Distribution in PHStat

| Poisson

## © 2002 Prentice-Hall, Inc. Chap 5-23

Poisson Distribution
Characteristics

 Mean
P(X) = 0.5
.6

   EX    .4
.2
N 0 X

  XiP  Xi  0 1 2 3 4 5

i 1
P(X) = 6
 Standard deviation .6
.4
and variance .2
  
2
  0
0 2 4 6 8 10
X

## © 2002 Prentice-Hall, Inc. Chap 5-24

Hypergeometric Distribution

##  “n” Trials in a sample taken from a finite

population of size N
 Sample taken without replacement
 Trials are dependent
 Concerned with finding the probability of “X”
successes in the sample where there are “A”
successes in the population

## © 2002 Prentice-Hall, Inc. Chap 5-25

Hypergeometric Distribution
Function
 A   N  A e.g.: Three Light bulbs were
   selected from ten. Of the ten,
 X  n  X 
P X   four were defective. What is the
N probability that two of the three
  selected are defective?
n 
P  X  : probability that X successes given n, N , and A
n : sample size  4  6 
N : population size   
P  2   2 1 
 .30
A : number of "successes" in population 10 
 
X : number of "successes" in sample 3 
X
 0,1, 2, , n Chap 5-26
Hypergeometric
Distribution Characteristics

 Mean
A
   EX   n
N
 Variance and Standard Deviation
nA  N  A N  n Finite

 
2
Population
N2 N 1 Correction
Factor
nA  N  A N  n

N 2
N 1
© 2002 Prentice-Hall, Inc. Chap 5-27
Hypergeometric
Distribution in PHStat

Hypergeometric …